INTRODUCTION

Robert J. Shapiro

Under Secretary of Commerce for Economic Affairs

This is the third annual report from the Commerce Department on the digital
economy. The first two reports were titled, The Emerging Digital Economy. This
third edition has a new title, because the digital economy and digital society
are no longer "emerging." They are here. Americans have definitively crossed
into a new era of economic and social experience bound up in digitally-based
technological changes that are producing new ways of working, new means and
manners of communicating, new goods and services, and new forms of community.

This report, like its two predecessors, measures the economic performance of
information technology (IT) industries and their substantial impact on growth
and inflation, and sketches the emerging dimensions of e-commerce. For the
first time, it can be reasonably claimed that the extraordinary dynamism of the
IT sector and the new, proliferating forms of e-business and e-commerce are
part of an enduring and broad economic pattern. The rapid pace and
proliferation of innovation associated with IT, and the substantial increases
in U.S. productivity and growth associated with IT-related innovation, now
appear to be persistent.

At the core of the proposition that the digital economy can produce higher
long-term productivity gains and national growth than we knew in the 1970s and
1980s are certain singular qualities associated with information technologies.
Most obviously, these technologies provide new ways of managing and using a
resource that is common to every sector and aspect of economic life; namely
information. Compared, for example, to the introduction of refrigeration or jet
propulsion, IT innovations can be applied across the economy and throughout the
economic process. As a result, economic gains directly associated with
improving the capacity to obtain, process and transmit information mount up.

Further, many IT markets exhibit what economists call "network effects": The
more the technology is deployed, the greater its value. Compare certain
information technologies to automobiles. When you own a car, its value to you
is basically the same whether 5,000 or 1 million other people own the same
brand of automobile. When you buy a computer operating system or graphics
program, its value to you increases as more people buy it, because their
purchases of the same program increase your ability to digitally communicate
and interact. As these forms of innovation spread, the productivity benefits
may increase at a faster rate than simply arithmetically.

The spread of IT innovations in the digital economy affect growth in other
ways. For example, IT innovations appear to raise business investment in
equipment. The last seven years have seen the fastest growth of business
investment in equipment on record, and IT investments have accounted for almost
two-thirds of that growth. The digital economy also can stimulate improvements
in workers' skills, since many firms have to train their employees to use
information technologies. This may be one reason why Americans across the work
force are making real wage gains for the first time in two decades. Further, IT
markets with the network effects described above tend to be dominated by a
handful of products and companies, and this tendency creates the possibility of
beneficial economies of scale.

Perhaps most important of all, a dynamic of cascading or continuous innovation
has characterized the development and deployment of information technologies in
this period. Productivity gains come not just from deploying innovative
technologies that enable workers to process information faster. In addition,
firms intent on taking advantage of innovative new technologies often have to
rethink the way they operate and reorganize their operations, which can produce
a round of organizational innovation. Many firms also have discovered that the
new technologies can be used to develop and produce new goods or services for
themselves, producing yet another round of innovation. Furthermore, as these
areas of potential are widely recognized and the process spreads from firm to
firm, this generates demand for faster information processing. This can lead to
another round of innovation in IT itself-- part of the basis for the doubling
of chip capacity every 18 months, articulated as Moore's Law-- and the cascade
can begin again. A leading example of this dynamic is the Internet itself.
Regular and large increases in chip power provided a technological foundation
for the Internet, which in turn generated myriad innovations first in software
and then in how businesses organize themselves and operate, which in turn has
led to more myriad innovations in the goods and services available to
businesses and individuals.

The complex of hardware and software innovations that encompass the IT sector
have made information the most important basis for creating value in the
economy. The process of creating value from information, throughout and across
the economy, is the ultimate basis for the digital economy. This digital
economy is just beginning today, and this report will provide a sketch of its
current bounds.